DECISION MAKING PROCESS

Defining the problem/Setting the goal

Identifying the alternatives
Evaluating the alternatives
Selecting the best alternative
Implementing the decision
DECISION MAKERS
SECURITY ANALYSTS
INVESTMENT ADVISORS
FUND MANAGERS
INVESTMENT BANKERS
CREDIT RATERS
CORPORATE BANKERS
INDIVIDUAL INVESTORS


EQUITY
SHAREHOLDERS
MAY
INVESTIGATE
INTO

WHAT ARE BUSINESS PROSPECTS
WHAT ARE COMPETITIVE STRENGTHS AND
WEAKNESSES
WHAT STRATEGIC INITIATIVES HAVE BEEN
TAKEN OR PLANNED TO TAKE, IN RESPONSE TO
BUSINESS OPPORTUNITIES AND THREATS
WHAT IS EARNINGS POTENTIAL
WHAT IS THE RECENT EARNINGS PERFORMANCE
HOW SUSTAINABLE ARE CURRENT EARNINGS
WHAT ARE THE DRIVERS OF PROFITABILITY
WHAT ESTIMATES CAN BE MADE ABOUT
EARNINGS GROWTH
WHAT IS CURRENT FINANCIAL CONDITION
WHAT RISKS AND REWARDS DOES FINANCING
STRUCTURE PORTRAY
ARE EARNINGS AVAILBLE TO VARIABILITY
DOES IT POSSESS FINANCIAL STRENGTH TO
OVERCOME A PERIOD OF POOR PROFITABILITY

HOW DOES IT COMPARE WITH ITS
COMPETITORS, BOTH DOMESTICALLY AND
GLOBALLY

WHAT IS REASONABLE PRICE FOR THE
COMPANYS STOCK


CREDITORS AND LENDERS
MAY LOOK INTO


WHAT ARE BUSINESS PLANS AND PROSPECTS
WHAT ARE ITS NEEDS FOR FUTURE FINANCING

WHAT ARE ITS LIKELY SOURCES FOR PAYMENT OF
INTEREST AND PRINCIPAL
HOW MUCH CUSHION DOES IT HAVE IN ITS
EARNINGS AND CASH FLOWS TO PAY INTEREST
AND PRINCIPAL
WHAT IS THE LIKELIHOOD IT WILL BE UNABLE
TO MEET ITS FINANCIAL OBLIGATIONS
HOW VOLATILE ARE ITS EARNINGS AND CASH
FLOWS
DOES IT HAVE THE FINANCIAL STRENGTH TO PAY
ITS COMMITMENTS IN A PERIOD OF POOR
PROFITABILITY
BUSINESS ANALYSIS

Analyst should know the business she/he is covering
First, the business model (business concept or
business strategy)is to be identified.
What is the company aiming to do?
How does it see itself to be generating value?

Strategy Analysis
Strategy analysis Assessing a companys expected
strategic responses to its business environment and
the impact of these responses on its future success and
growth.

Many details of the business to know, which may be
considered under five categories.
PRODUCT
Type
Demand
Price elasticity of demand
Substitutes Differentiated on price or quality
Brand
Patent protection


PRODUCTION AND DISTRIBUTION
Production process
Marketing process
Distribution channels
Supplier network
Cost structure
Economies of scale
Technology

KNOWLEDGE BASE
Direction and pace of technological change
R&D
Managerial talent
Ability to innovate in product development
Ability to innovate in production technology

INDUSTRY
Capacity in the industry Excess capacity or under-
capacity
Number of firms and their sizes
Barriers to entry
Firms position in the industry
Competitiveness of suppliers
Relationships
ENVIRONMENT
Political
Legal
Regulatory
Ethical
FINANCIAL STATEMENT ANALYSIS
AN IMPORTANT AND INTEGRAL PART OF
BUSINESS ANALYSIS
IT IS THE APPLICATION OF ANALYTICAL TOOLS
AND TECHNIQUES TO FINANCIAL DATA TO
DRAW INFERENCES OR TO EXTRACT
INFORMATION.

FINANCIAL STATEMENTS
REFLECTIONS OF BUSINESS
ACTIVITIES
PLANNING ACTIVITIES
Information on company objectives, strategies and tactics, market demands,
competitive analysis, sales strategies (pricing, promotion and distribution),
management performance, etc. is often revealed in financial statements.
FINANCING ACTIVITIES
Methods used to raise the funds
External financing Equity and debt
Internal financing Earnings retention
INVESTING ACTIVITIES
Acquisition and maintenance of assets Operating assets and
financial assets
OPERATING ACTIVITIES
Primary source of earnings
May include R&D, procurement, production, marketing and administration
NATURE OF FINANCIAL
STATEMENTS

FINANCIAL STATEMENTS ARE THE LENS ON
THE BUSINESS

BUT OFTEN PRODUCE A BLURRED PICTURE

FINANCIAL STATEMENT ANALYSIS FOCUSES
THE LENS TO PRODUCE A CLEARER PICTURE
OBJECTIVES OF FINANCIAL
STATEMENT ANALYSIS
IT REDUCES RELIANCE ON HUNCHES, GUESSES
AND INTUTION FOR BUSINES DECISIONS
IT DECREASES THE UNCERTINITY OF BUSINESS
ANALYSIS
IT DOES NOT LESSEN THE NEED FOR EXPERT
JUDGEMENT, BUT, INSTEAD, PROVIDES A
SYSTEMATIC AND EFFECTIVE BASIS FOR BUSINESS
ANALYSIS

ACCOUNTING ANALYSIS
PROCESS OF EVALUATING THE EXTENT TO
WHICH A COMPANYS ACCOUNTING REFLECTS
ECONOMIC REALITY

ASSESSING THE EFFECTS OF ACCOUNTING
POLICIES ON FINANCIAL STATEMENTS

ADJUSTING THE STATEMENTS TO BOTH BETTER
REFLECT THE UNDERLYING ECONOMICS
BALANCE SHEET
Figures have been taken from the balances shown on
the books of accounts

Pro forma balance sheet--Hypothetical balance sheet
that adjusts regular balance sheet to reflect the
changes which are contemplated

Object is to show the financial condition on a certain
date, yet the values show the cost at which they are
acquired
INCOME STATEMENT
Also known as Profit and Loss Account/Statement
Representation of the operating activities
Measures financial performance between balance sheet
dates.
Provides details of revenues, expenses, gains, and losses for
a time period.
Related to balance sheet as it states the nature of those
transactions that have changed the earned surplus as
reported in two successive balance sheets.
BOTTOM LINE EARNINGS (NET INCOME) INDICATES
PROFITABILITY.

Interrelationship among income, cash flow, and assets
is captured by the concept of economic earnings.
Economic earnings is defined as the net cash flows
plus the change in market value of the firms net
assets.
Market value of the firms assets is equal to the present
value of their cash flows discounted at the required
rate of return.

Distributable earnings are defined as the amount of
earnings that can be paid out as dividends without
changing the value of the firm. This concept is derived
from the Hicksian definition of income, which goes:
The amount that a person can consume during a period of
time and be as well off at the end of that time as at the
beginning.
Sustainable income refers to the level of income that can be
maintained in the future given the firms stock of capital
investment (e.g. fixed assets and inventory).
Permanent earnings amount that can normally be earned
given the firms assets and equals the market value of those
assets times the firms required rate of return.
Financial reporting concept of incomeaccounting
income is often quite different. The analyst,
therefore, needs to relate accounting income to the
economic income.

STATEMENT OF SHAREHOLDERS
EQUITY
Provides changes in the accounts that make up equity
Useful in identifying reasons for changes in equity
holders claim on the assets of the company
STATEMENT OF CASH FLOWS
Accounting yields numbers different from cash flow
accounting
Reports cash inflows and cash outflows separately for
operating, investing, and financing activities over a
period of time
ARTICULATION OF FINANCIAL
STATEMENTS
Linking of Financial Statements by design
Period- of- time statements (income statement,
statement of cash flows, and statement of
shareholders equity) explain point-in-time balance
sheets
Every transaction captured in period-of-time
statements impacts the balance sheet.

Cash Flow Statement Year 1
Cash from Operations
Cash from Investing
Debt Financing
Equity Financing
Net Change in cash
Statement of Shareholders
Equity Year 1
Investment and disinvestment by
owners
Earnings
Net Change in owners equity

Income Statement Year 1
Cash from operations
+ Accruals
Net Income
Ending Balance Sheet
Year 0
Cash 0
+Other Assets 0
-Liabilities 0
Owners Equity 0
Ending Balance
Sheet Year 1
Cash 1
+Other Assets 1
-Liabilities 1
Owners Equity 1
1. Net cash flows from all activities increases cash in
the balance sheet.
2. Cash from operations increases net income and
shareholders equity.
3. Cash investments increase other assets.
4. Cash from debt financing increases liabilities.
5. Cash from equity financing increases shareholders
equity.
6. Accruals increase net income, shareholders equity,
assets, and liabilities.

TOOLS OF FINANCIAL ANALYSIS
Comparative financial statement analysis
Common-size financial statement analysis
Ratio analysis
Cash flow analysis
Valuation models
COMPARATIVE FINANCIAL
STATEMENT ANALYSIS

Reviewing consecutive balance sheets, income
statements or statements of cash flows from period to
period.
A comparison of statements over many periods can
reveal the direction, pace, and extent of trend.
Also known as horizontal analysis

TECHNIQUES OF COMPARATIVE
ANALYSIS
Year-to-year Change analysis
* Useful for comparing over relatively short-time
periods.
* Has the advantage of presenting changes in
absolute amounts s well as in percentages
Index-number Trend analysis
* Using index numbers with a base period for
all items
Certain changes, like those from negative amounts to positive
amounts cannot be expressed by means of index numbers
COMMON SIZE FINANCIAL
STATEMENT ANALYSIS
Knowing what proportion of a group or a sub-group is
made up of a particular account
In analyzing balance sheet, total assets are taken as
100%, then accounts within these groupings are
expressed as a percentage of their respective total
In analyzing income statement, sales are often set at
100% with the remaining income statement accounts
expressed as a percentage of sales.
Also called vertical analysis given the up-down (or
down-up) evaluation of accounts
RATIO ANALYSIS
Mathematical relation between two quantities
Ratio is simple arithmetic calculation, but its
interpretation is more complex
Several factors influence the ratios which may include
economic events, industry factors, management
policies, and accounting methods
Any limitations in accounting measurements impact
the effectiveness of ratios.
Ratios must be interpreted with care because factors
affecting the numerator can correlate with those
affecting with denominator.
RATIOS-- USES
Measuring Risk
Liquidity- Ability to meet short-term obligations
Capital structure and solvency Ability to meet
long term obligations
Measuring profitability
* Return on investment
* Operating performance
* Asset utilization
Measuring value
CASH FLOW ANALYSIS
Used as a tool to evaluate the sources and uses of funds
Used in cash flow forecasting
Part of liquidity analysis
Provides insights into how a company is obtaining its
financing and deploying its resources
VALUATION MODELS
Refers to estimating the intrinsic value of an
organization or its equity stock
Present value theory --- Value is equal to the sum of
all expected future payoffs that are discounted to the
present at an appropriate discount rate

Additional Information
Management Report
Auditor Report
Explanatory Notes
Supplementary Information


Limitations of F.S. Analysis
QUALITY OF FINANCIAL ANALYSIS DEPENDS ON
THE RELIABILIITY OF FINANCIAL STATEMENTS
THAT IN TURN DEPENDS ON THE QUALITY OF
ACCOUNTING ANALYSIS
Accounting limitations affect the FSA
Lack of uniformity leading to comparability problem
Discretion and imprecision in accounting